Fed not just behind the curve on inflation problem — ‘it’s not even on the curve,’

ALEXIS CHRISTOFOROUS: I want to continue the market conversation now and welcome to the show Chris Brightman CEO and chief investment officer at Research Affiliates. So Chris, it’s turning out to be a pretty volatile week for Wall Street. Do you think it’s going to continue for the rest of the year? And if so, how are you going to play the volatility card to your advantage?

CHRIS BRIGHTMAN: Yes, I think increased volatility in the months and maybe even the years ahead is likely less to do with the virus and Omicron and more to do with the fact that the Fed is behind the curve on inflation.

– And, sir, I want to ask you, how surprised were you that Chair Powell made this sort of decision that the Fed would consider tapering more quickly? The timing to me is very curious. So it comes on the heels of this variant that’s just emerged. We’ve seen, you know, the prices of things like iron ore and corn fall, lumber fall. So why is he suddenly jumping on the bandwagon that we’ve all been on for the longest time saying it’s time to halt inflation? Is it curious to you at all?

CHRIS BRIGHTMAN: Well I’m not at all surprised that the Fed has pivoted to recognize that we’ve got an inflation problem. I guess the surprising thing is that it has taken them as long as it has. I mean, it’s pretty obvious what happened. We’ve been running, if not in name, in practice, MMT, basically coordinating monetary and fiscal policy, coordinating the activities of the Fed and the Treasury to wire transfer huge amounts of money into bank accounts. And that’s created a huge increase in demand. And supply is not that elastic and so you have constrained supply, a huge increase in demand, a classic recipe for inflation.

I worry that tapering– quantitative easing is not going to do the trick. I mean, quantitative easing didn’t create inflation. And it really doesn’t because it’s just shuffling one government claim for another government claim on the balance sheet of banks who have enormous amounts of excess reserves. It can cause liquidity problems. And, you know, that’s a concern that we could have a market problem if we have problems in the plumbing system. But it’s not going to fix inflation. NN: Putin’s oil card will be played. Peace in the Ukraine is not even close…. The markets especially the Algo guys do not know how to play this.. GOOD we do! So Biden cut off Starbucks chocolate flavored coffee and big Macks… BooHoo! And Putin cuts off Potash, Uranium, Nickel, Palladium, Platinum, Oil and Natural Gas… Who do you think will win?

For the Fed to fix the inflation problem, it’s going to require real interest rate increases. And I think they’re really constrained from doing so because of our massive debt. And it really puts the equity market at risk. You know, we explain the very, very high PE multiples that we see– rightfully so– by the extraordinarily low interest rates. But you take away the extraordinarily low interest rates and there’s no kind of reason for the very high prices we see in equity markets.

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ALEXIS CHRISTOFOROUS: Yeah, those are great points–

CHRIS BRIGHTMAN: So I worry that it could happen– go.

ALEXIS CHRISTOFOROUS: Yeah, well, I was going to say I’m glad that you made the connection there or highlighted the fact that there really isn’t much of a connection between the taper and inflation. It’s really more about those interest rates. And if that’s going to be the environment going forward, I mean, you know, Fed Powell is now telegraphing that rates could start to rise in the spring. If that is the case, if inflation sticks around and that is the case and we continue to see high valuations, how do you pick and choose the best stocks for the portfolio?

CHRIS BRIGHTMAN: Well, I think the stocks that are of most interest-sensitive in today’s environment are the high flying tech stocks, EV companies, Tesla, of course, but also Amazon and others that benefit enormously when you use a negative discount rate, a negative real discount rate to forecast future cash flows. There’s a lot of risk, I think. Most people are ignoring– and I think at their financial peril– the frothiness that we see in capital markets, you know, everything from the stock, the growth stocks that we were just talking about, to cryptocurrencies and NFTs. All of this is propped up by extraordinary liquidity.

If that liquidity goes away and interest rates rise, I think we’re going to see a real correction. If you’re worried about inflation, you probably want to be, you know, out of bonds, maybe even short bonds, or another way of saying that is borrowing money at long-term fixed rates to invest in real assets like REITs and commodities. If you’re worried about liquidity being withdrawn from the capital markets in a correction, you probably want to be away from what’s done extraordinarily well in the massive injections of liquidity and rotate into what’s underperformed, which would be, say, European stocks and value stocks here in the US.

– And sir, I want to ask you really quickly, how much are we underestimating the political headwinds that we face? You know, funding needs to be figured out by this week. The debt ceiling, you know, it needs to be raised or it needs to be suspended. The Treasury is saying we won’t be able to pay our bills beyond the 15th.

CHRIS BRIGHTMAN: I think it’s best to ignore those things. You know, it makes for great headlines. And you have political battles. But debt ceilings always get raised. Continuing resolutions for funding the government always get done. They may get done at the last minute, but, yeah, I really don’t worry about that. I think that the the issue that’s very important is, is Congress going to be able to manage inflation through fiscal policy? Because if the Fed can’t– and I think they are constrained. We have so much debt that they can’t really raise interest rates very much. That means that fiscal policy is going to have to manage inflation, which is– means more tax increases than spending increases. And that’s just not what Congress likes to do.

ALEXIS CHRISTOFOROUS: All right, no, they don’t. Chris Brightman of Research Affiliates. Thanks so much for being with us.